Euro Ends 2-Year Slump on Draghi Backstop; Yen Loss Tops Majors

The euro halted a two-year losing
streak as European Central Bank President Mario Draghi’s
commitment to backstop the shared currency stymied a debt-
contagion threat.

In its 14th year, the 17-nation currency rebounded versus
the greenback after sliding almost 10 percent during the prior
two years. The yen extended the largest loss versus the dollar
among major currencies as Prime Minister Shinzo Abe put pressure
on the central bank to increase monetary stimulus. The U.S.
currency was little changed as U.S. policy makers struggled with
deficit control and the Federal Reserve extended its record-low
interest rate target and bond-buying plans.

“The ECB has gone a long way to suppress the forces of the
crisis and contain systemic risk,” said Lena Komileva, London-
based chief economist at G+ Economics Ltd. “This is the primary
reason the euro has been as strong as it has. Initially this
year, the market underestimated the effectiveness of the ECB.’

The euro was up 2 percent for the year to $1.3216 yesterday
in New York, after dropping 3.2 percent last year and 6.5
percent in 2010. It remained below its life-time peak of $1.6038
reached on July 15, 2008, traded as high as $1.3487 on Feb. 24
and as low as $1.2043 on July 24.

The yen was down 10.5 percent to 85.96 per dollar. Japan’s
currency has weakened 12.3 percent to 113.61 per euro.

Winners, Losers

The Brazilian real has lost 8.8 percent versus the dollar
in 2012, the second biggest loser after the yen. The South
Korean won leads all 16 of the dollar’s biggest peers with a
gain of 7.7 percent.

The South African rand leads all major currencies this
month against the greenback, appreciating 5.1 percent.

The ECB’s Draghi said July 26 that he would do whatever it
took to ensure the resilience of the euro and announced in
September a bond-buying plan, which pledges unlimited support
for countries that sign up to economic reforms as part of a
bailout from Europe’s rescue fund. The Outright Monetary
Transactions program caused bond yields of the region’s most-
indebted nations, such as Spain, to decline.

The shared currency touched its annual low on July 24 as
euro-zone policy makers struggled to find a policy solution,
with creditor countries in the north demanding austerity from
the south as a condition for aid. Leaders that week approved a
third bailout plan for Greece.

ECB Policy

The ECB has also flooded the banking sector with more than
1 trillion euros ($1.3 billion) beginning in December 2011. On
July 5, the Frankfurt-based central bank cut its benchmark
interest rate to an historic low of 0.75 percent and took its
deposit rate to zero.

“The fact that Draghi said in July that he would do
whatever it would take was very, very important,” said Doug Borthwick, managing director and head of foreign exchange at
Chapdelaine & Co. “The ECB had talked about using a Bazooka a
number of times before but this was the first time that Draghi
actually showed it from behind the curtain.”

The yen is down 14 percent this year, posting the biggest
depreciation among the 10 developed-nation currencies tracked by
Bloomberg Correlation-Weighted Indexes.

Abe, who was approved as prime minister by Japan’s
parliament after his party won a landslide victory in the Dec.
16 vote, said two days earlier that he would push for “bold
monetary easing.” During his campaign and afterwards, Abe has
pledged to weaken the currency, stoke inflation and achieve 3
percent nominal economic growth.

Japan’s Economy

Japan’s deflation-plagued economy has contracted 7 percent
since 2007 as six prime ministers, including Abe in his first
term, failed to reverse the course.

“The yen will weaken further given the election of Abe,”
said John Taylor, chairman and founder of FX Concepts LLC, said
in a telephone interview from his New York office on Dec. 20.
“The yen weak versus the U.S. dollar into the first week or so
of February,” reaching 90 per dollar before reversing course.

The median forecast of 50 strategists and economists
surveyed by Bloomberg predict the yen will trade at 87 per
dollar at the end of 2013.

The Dollar Index, which IntercontinentalExchange Inc. uses
to track the greenback against the currencies of six U.S.
trading partners, fell 0.6 percent to 79.683, from 80.178 at the
end of 2011, a year it gained 1.5 percent.

U.S. politicians this weekend will continue efforts to
reach a budget agreement, to avert $600 billion in tax increases
and spending cuts that have become known as the fiscal cliff.
The Fed will add in January $45 billion in Treasuries to the $40
billion in mortgage bonds it’s currently purchasing a month in
its third round of bond buying, known as quantitative easing.

Fed Stance

“The Fed announced that it will be purchasing asset at the
pace of $85 billion a month for a potentially unlimited time and
the dollar wasn’t significantly weaker this year,” said Brian Daingerfield, a currency strategist at Royal Bank of Scotland
Group Plc’s RBS Securities unit in Stamford, Connecticut. This
is in part “because most countries among the Group of 10
nations are also easing.”

The dollar index (DXY) will rise to 80.6 in the first quarter of
2013, according to the median estimate of economists surveyed by
Bloomberg. The greenback will rally to $1.19 per euro by the end
of June next year, according to RBS.

“On a growth basis, the dollar in 2013 will be supported
versus the U.K. pound, the yen and the euro,” Daingerfield
added. Even with the likely fiscal drag, “the current
underpinnings of U.S. growth are better now than they have been
at any point during the recovery.”